An index is a statistical composite that is used to indicate the performance of a market or a market sector over various time periods. Examples of indices that are used to gauge the performance of stocks, bonds and other securities in the United States include the Dow Jones Industrial Average, the National Association of Securities Dealers Automated Quotations (NASDAQ) Composite Index, the New York Stock Exchange (NYSE) Composite Index, etc. In general, the Dow Jones Industrial Average contains thirty (30) stocks that trade on the NYSE as well as NASDAQ, and is a general indicator of how shares of the largest United States companies are trading. The NASDAQ Composite Index is a composite index of more than three thousand (3,000) companies listed on the NASDAQ (also referred to as over-the-counter or OTC stocks). It is designed to indicate the stock performance of small-cap and technology stocks. Finally, the New York Stock Exchange Composite Index is a composite index of shares listed on the New York Stock Exchange. No index exists for certain types of pooled financial instruments, such as Small Business Administration SBA 7(a) loans.
The SBA is an independent U.S. federal agency created for the protection of the interests of small business. There are more than 27 million small businesses in the U.S. that employ more than half of all private sector employees and generate 65% of net new jobs as measured between 1993 and 2009. SBA 7(a) loans are the largest component of the SBA's business loan program. These loans are only available on a government guaranteed basis, which range from 75% to 90% of the loan having a $5 million maximum loan amount. The guarantee loan program originates from a commercial lender.
The guaranteed portion of the loan is eligible to be sold and then pooled into securities under the SBA 7 (a) Pooling Program. The SBA Pools are referred to as pass-through securities where pool assemblers actively bid on the loans, aggregate the loans thus acquired through bidding, and optionally pass them into the securities market for trading. Approximately 95% of those reaching the market are floating rate pools. All the pools are issued with an original face amount of the bonds. By way of example, 10 individual loans may comprise a $10,000,000 pool, whereby a monthly principal and interest paid by the borrowers of the underlying loans is passed through to an investor in the pool, based on the investor's pro rata share of the pool.
The SBA pools amortize and are issued with an original face amount of the pool and begin with a factor of 1.0000. Each month following the issuance month, as principal is paid down by the borrower, the factor is reduced. When the last dollar of principal is paid back the factor will be 0.000000. A factor is calculated by dividing the current face amount of the pool by the original face amount of the pool.
Although over different periods, requirements for pool parameters can change, by way of example, as of January 2011, the pools must have had the following characteristics: (a) a minimum original pool size of $1.0 million, (b) a minimum of four (4) loans in a pool, (c) that no single loan could consist of more than 25% of a pool for standard pools, (d) that no single loan could consist of more than 10% of a pool for Weighted Average Coupon (WAC) pools, (f) a maximum difference in borrower rates would be limited to 2%, (g) all loans in a pool required a monthly repayment schedule, (h) loans could vary in remaining maturity by no more than 20% for standard pools, (i) loans could vary in remaining maturity by no more than 24% for WAC pools and (j) prepayment penalties on loans with original maturities of 15 years of longer. SBA 7(a) loans have a loan amortization of monthly principal payments in addition to possible prepayments. Such principal prepayments are referred to as the constant prepayment rate (CPR) within the SBA industry. The CPR is calculated as the total dollar amount of notional value loan payoffs as an annualized percentage of the total outstanding notional loan value. The principal pay-downs (amortization plus prepayment) are reported with a two month lag, such that the pay-down return, for example February is based on the reported December prepayment data. The CPR is sometimes referred to as the prepayment speed. High prepayment speed CPR will reduce the income to the investor or lender.
Currently, there are no reliable SBA 7 (a) floating rate pool indices to assist the market in making considered judgments about investing a pool. An index of SBA 7 (a) issued pools would provide investors a reliable bond-like investment if an index was constructed from pools with certain characteristics. Therefore, a need exists to create the universe of pools having certain characteristics and from that universe a selection process for inclusion of these pools in an index that reflects the performance to SBA 7 (a) pools held for investment. The magnitude and complexity dealing with the dynamics of such pools also necessitates an automation process by which the pools having certain characteristics are identified and the application of selection criteria to qualify only those pools that produce an investor quality index.